Updated: September 6, 2020 2:47:13 pm
India’s foreign exchange (forex) reserves increased by $ 3.883 billion to hit an all-time high of $ 541.431 billion in the week ending August 28. (File photo)
India’s foreign exchange (forex) reserves surged $ 3.883 billion to hit an all-time high of $ 541.431 billion in the week ending August 28, data from the Reserve Bank of India (RBI) showed on Friday (September 4). India’s foreign exchange reserves had topped $ 500 billion for the first time in the week ending June 5, 2020, reaching an all-time high of $ 501.7 billion.
The current situation is in stark contrast to that of 1991, when India had to compromise its gold reserves to avoid a major financial crisis. In March 1991, India had foreign exchange reserves of just $ 5.8 billion; Today, the country can depend on its growing foreign exchange reserves to deal with any crisis on the economic front.
While the overall situation on the economic front is bleak, with India’s gross domestic product (GDP) growing hired 23.9 percent In the April-June quarter, and manufacturing activity and trade stagnant, the stock of foreign exchange reserves is a data that India can cheer in the middle of the Covid-19 pandemic.
What are foreign reserves?
Foreign exchange reserves are foreign assets in the form of gold, SDRs (IMF special drawing rights), and foreign currency assets (capital inflows to capital markets, FDI, and foreign commercial loans) accumulated by India and controlled by the RBI. .
The International Monetary Fund says that official foreign exchange reserves are held in support of a number of objectives, such as supporting and maintaining confidence in monetary and exchange-rate management policies, including the ability to intervene in support of the national currency or the Union.
It also limits external vulnerability by maintaining liquidity in foreign currency to absorb shocks in times of crisis or when access to loans is restricted.
Why are foreign reserves increasing despite the slowdown in the economy?
The oldest reason for the increase in foreign exchange reserves is the increase in investment by foreign portfolio investors in Indian equities and foreign direct investment (FDI). Foreign investors have acquired stakes in various Indian companies in recent months.
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After taking Rs 60 billion out of each of the debt and equity segments in March, Foreign Portfolio Investments (FPI), which are expecting a turnaround in the economy later this financial year, have now returned to the Indian markets.
On the other hand, the drop in crude oil prices has lowered the oil import bill, saving valuable foreign exchange. Similarly, remittances and trips abroad have been drastically reduced.
The sharp jump in reserves began with the announcement by Finance Minister Nirmala Sitharaman on September 20, 2019, to cut corporate tax rates.
What is the importance of the increase in foreign exchange reserves?
The growing foreign exchange reserves give comfort to the government and the RBI in managing India’s internal and external financial problems at a time of great contraction in economic growth. It serves as a cushion in the event of a crisis on the economic front, and is enough to cover the country’s import bill for a year.
Rising reserves have also helped the rupee to strengthen against the dollar. The ratio of foreign exchange reserves to GDP is around 15 percent.
The reserves will provide a level of confidence to the markets that a country can meet its external obligations, demonstrate the support of the national currency by external assets, help the government meet its foreign exchange needs and external debt obligations and maintain a reserve for national disasters or emergencies. .
What does the RBI do with the foreign exchange reserves at its disposal?
The Reserve Bank functions as custodian and administrator of foreign exchange reserves and operates within the general policy framework agreed with the government.
The RBI allocates dollars for specific purposes. For example, under the Liberalized Remittance Scheme, people can send up to $ 250,000 per year.
The RBI uses its forex kitty for the orderly movement of the rupee. Sell the dollar when the rupee weakens and buy the dollar when the rupee strengthens. Lately, the RBI has been buying dollars from the market to shore up foreign exchange reserves.
When the RBI absorbs dollars, it releases an equal amount in rupees. This excess liquidity is sterilized through the issuance of bonds and LAF securities and operations.
“Despite the global weakness of the dollar, the RBI does not seem willing to take a step back when it comes to reserve accumulation … sentiment in the rupee has been skewed by incessant purchases of dollars by of the central bank to strengthen its balance sheet, Abhishek Goenka, chief executive of IFA Global, had previously told The Indian Express.
Where are India’s foreign reserves kept?
The RBI Law of 1934 provides the general legal framework for the deployment of reserves in different assets in foreign currency and gold within the general parameters of currencies, instruments, issuers and counterparties.
Up to 64 percent of foreign currency reserves are held in securities such as Treasury bills from foreign countries, mainly the United States; 28 percent is deposited in foreign central banks; and 7.4 percent is deposited in commercial banks abroad, according to RBI data.
India also had 653.01 tonnes of gold as of March 2020, with 360.71 tonnes abroad in the custody of the Bank of England and the Bank for International Settlements, while the remaining gold is held domestically.
In terms of value (USD), gold’s share of total foreign exchange reserves increased from approximately 6.14% at the end of September 2019 to approximately 6.40% at the end of March 2020.
Is there a cost involved in maintaining foreign exchange reserves?
The return on India’s foreign exchange reserves in foreign central banks and commercial banks is negligible: analysts say it could be around 1%, or even less, considering falling interest rates in the United States and the euro zone.
There was a demand from some sectors that foreign exchange reserves should be used for infrastructure development in the country. However, the RBI had opposed the plan. Several analysts advocate giving more weight to the performance of currency assets than to liquidity, which reduces the net costs, if any, of holding reserves.
Another problem is the high relationship between volatile flows (portfolio flows and short-term debt) and reserves, which is around 80%. This money can come out quickly. There are some differences among scholars on the direct and indirect costs and benefits of the level of foreign exchange reserves, from the point of view of macroeconomic policy, financial stability, and fiscal or quasi-fiscal impact, said former RBI Governor YV Reddy. in one of his speeches.
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